Despite the market chaos in Europe, the region offers very attractive, select corporate investment opportunities for firms that carefully source and screen deals and have long-term staying power.
In advance of considering corporate investing in Europe, one must consider the dynamics affecting three key participants today: sovereigns, banks and private equity.
The eurozone became the focal point of the global financial crisis when some of its member states required foreign assistance to refinance debt. Initiatives to assist focused on providing liquidity, which initially came from the European Central Bank and then from the European authorities through the European Financial Stability Facility (EFSF) issues backed by guarantees given by member states.
The eurozone constitutes both the debtors and lenders. More than 60 percent of the exposure to peripherals (Greece, Ireland, Italy, Portugal, Spain) is owned by France, Germany and the UK; and less than 90 percent of this total exposure is owned by all of Europe — so this is a European issue to solve and not one that is easily separable away from Europe.
Solutions to improve the financial condition of the Eurozone are difficult to implement; and virtually all proposed put pressure on GDP or put further strains on balance sheets in the near and medium term. Indebted peripheral countries can only push so hard before social unrest precludes the execution of their programmes.
Europe's ability to resolve the crisis is complicated by having so many parties at the decision-making table; sovereign dynamics should create sustained downward pressure on the Eurozone economy — an important factor when thinking of corporate investing.
Banks also play a leading role in the corporate investing dynamics. In an effort to decrease the chances of another crisis like in 2008, Basel III was created requiring increased capital requirements. To achieve this, banks must do one (or more) of the following: sell assets (we are witnessing the asset disposal programmes); raise equity (this is unlikely given the difficult economic conditions currently); generate income (this is most unlikely to contribute adequately in near term); and/or tighten financing standards.
One should expect that disposition of assets and tightening of financing standards will continue for the foreseeable future. These will continue to put downward pressure on GDP in Europe making it more difficult to find companies with adequately attractive projected growth for corporate investing. However, since default rates correlate to tightening of financing standards, there should be an increasing number of opportunities as companies seek alternatives to lack of available refinancing.
To more completely understand the dynamics affecting the environment for corporate investing, one must also assess the asset flows of private equity participants.
Private equity firms' dry powder is at 90 percent of all-time highs. This is because 2006 to 2008 were huge fundraising years and firms were not able to deploy as usual due to the lack of financing in the market.
Private equity-backed deal volumes decreased since the crisis. For example, over the past year, Europe has experienced a 50 percent-plus decline in deal volume to $12 billion.
A record number (1,800-plus) of funds are attempting fundraising of almost $1 trillion.
Capital committed to investment in corporates in Europe typically has five years (plus select opportunities to extend depending on limited partnership agreements) to invest. Therefore, there should be large willingness to deploy capital over the next three years. This factor demands caution over the next couple years.
However, if the current conditions continue, it would be difficult to imagine market dynamics changing to facilitate deployment. This, in part, is why so many are fundraising now as their deployment performance is unlikely to change in the near term. It is also difficult to see how it is possible to raise such amounts. A potential counter to this is that relatively attractive private equity returns may create allocation shifts to the asset class as investors seek returns. However, if that doesn't happen, we may see a reduction in the number of private equity participants. This means that corporate investing will likely get advantaged with time.
Europe is the largest economy in the world with a strong and reliable framework for investors. It has stood the test of time and will continue to do so. Corporate investing has slowed to a trickle, yet, the timing is right with an understanding of the market and asset class dynamics, thoughtfulness in sourcing and discipline in assessing
opportunities. While corporate investing in Europe can be very interesting in this environment, many factors indicate that it will get increasingly attractive.
Scott Freidheim is chief executive officer, Europe for Investcorp.